Markets in Focus: Regional Markets, Credit and Cash on the Move
Key findings
- Global equities continued to rally in Q1 2024, while developed-market government bond prices declined. Shifts from cash and money-market funds into riskier market segments could be a dynamic for the remainder of the year.
- Post-2020, credit markets have had tighter correlations to other asset classes, challenging traditional diversification strategies.
- Quality stocks have led the U.S. and European markets, but value stocks have led Japan’s rebound. Wide yield spreads between equities and bonds have pushed U.S. valuations higher compared to recent history.
In Q1 2024, global equity markets rose by 8% in USD terms, continuing their strong performance from 2023. In contrast, developed-market sovereign bonds declined just over 2% due to persistent inflation concerns, eroding much of the previous year's gains.[1] With continued uncertainty around the speed and timing of central banks' interest-rate pivots, and because substantial capital has remained on the sidelines in money-market funds, a potential shift of cash into riskier assets, such as longer-duration bonds, corporate credit and equities, could be in scope over the balance of the year.[2]
In last quarter's edition of Markets in Focus, we explored the changing relationship between government bonds and equities. In this quarter's post, we focus on the relationship between corporate bonds and equities. Considering the continued bull market in stocks, we examine the prevailing risks in the U.S. markets and the implications for investors choosing to move out of cash positions in 2024. This quarter also marks the start of our integrating fixed-income commentary into this quarterly analysis, to provide a comprehensive view into public markets.
Diminished diversification benefits from credit carried into Q1
Current conditions in global credit markets have been shaped by the tailwinds of high coupons, the possibility of impending rate cuts and growing confidence in a U.S. "soft-landing." We believe vigilance is warranted, however, given the lingering effects of shocks related to the COVID-19 pandemic.
In the following video, MSCI's head of portfolio management research, Andy Sparks, discusses the relationships within the bond markets across the credit spectrum, as well as between bond and equity markets, in the four years leading up to 2024 and during the first quarter of the year.
Putting Q1 bond returns into perspective
Download Transcript (PDF, 99KB)
Using the MSCI Multi-Asset Class Risk Model, we observed that correlations between corporate spreads and government bonds remain elevated, suggesting a continuation of diminished diversification benefits from debt investments. Around the world, both investment-grade and high-yield credit markets have become more closely coupled to equity markets.
Credit has struggled as a diversifier since the COVID-19 pandemic
Loading chart...
Please wait.
Data is from January 2009 through March 2024. Correlations are based on the short-horizon MSCI Multi Asset Class Model (MAC.S). Correlations use the market factor for equities, five-year factor for government debt and spread factor for investment-grade and high-yield debt.
Global equities marked by regional differences in style performance
Although global equities were up almost 50% since the start of 2020, they still exhibit patterns that emerged during the COVID-19 pandemic. Over the last four years, the whipsawing sentiment between value and growth stocks has contributed to divergence in regional performance.
Growth stocks in the MSCI ACWI Investable Market Index (IMI)[3] led value throughout 2020, but the trend reversed after the announcement of a vaccine breakthrough and continued alongside rate hikes in 2022. The AI-driven rally that began in late 2022 meant growth stocks surged once again. These broad characterizations mask important regional variations, however.
2020s characterized by whipsawing sentiment in value and growth
Loading chart...
Please wait.
Returns are gross in USD for the MSCI Growth and MSCI Value Indexes relative to their parent indexes from Dec. 31, 2019, to March 31, 2024.
In Q1 2024, the so-called Magnificent Seven have driven the U.S. growth rally in equities, despite diverging fundamentals. In addition, European growth stocks, led by firms such as Novo Nordisk A/S and SAP, have outperformed, increasing European firms' weight in the MSCI Thematic Megatrend Indexes and contributing to the momentum factor's strong performance.
Outside the U.S. and Europe, value has led in emerging markets (EM) and Japan, pushing Japan to the top of developed-market returns over the past year, with gains also reflecting improved corporate governance.
US and Japan were leaders in developed markets, and India and Taiwan in EM
In the first quarter of 2024, developed markets, led by the U.S. and Japan, outperformed EM by a significant margin, as measured in USD. Emerging markets ended the quarter up slightly, as gains in India and Taiwan were offset by a continued slide in Chinese stocks.
All of the MSCI Thematic Indexes — except for transformative technology, which outperformed the MSCI ACWI Index by a wide margin — had a challenging start to the year.
Top performers in Q1: Japanese equities and the momentum factor
Loading chart...
Please wait.
The exhibit shows regional variations of market-cap and non-market-cap MSCI indexes from Dec. 29, 2023, to March 31, 2024, for market-illustrative purposes during this period only and does not represent long-term index performance. For 1-, 5- and 10-year performance data, please see https://www.msci.comhttps://www.msci.com/end-of-day-data-search. We show the absolute return of the parent indexes and the relative returns of derivative indexes, where available for the region. Holding the cursor over a relative-return cell shows the respective contributions to the quarterly relative return from country, currency, industry, style and stock-specific exposures.
An eye toward valuations in the US
The growth rally in U.S. equities throughout 2023 and into the first quarter of this year could raise the specter of the U.S. market's being "priced for perfection" relative to other regions. In the following exhibit, we show that the MSCI USA Index is nearing a two-decade high in relative valuation, based on the difference in forward earnings and real bond yields. International stocks were not at the same levels, using the same measure.
In the current climate of reduced equity volatility and the consequent lower put-option premiums relative to historical norms,[4] investors cautious about high U.S. valuations could observe that this condition offers the possibility of gaining reasonably priced downside protection against increasing volatility.
US relative valuation higher than historical average
Coming off the sidelines
Based on valuations, and other signals such as macroeconomic sensitivity and sentiment, our adaptive multi-factor framework favored the value factor, as of March 31, 2024, as it did at the close of last year. Investors contemplating repositioning their cash in the year ahead may wish to consider the impacts of the changing equity-credit relationship and growing regional disparities as they revise their allocations.
Data is from January 2004 through March 2024. The yield spread is the difference in forward earnings yield and U.S. real bond yields, based on consensus estimates for the MSCI USA and MSCI ACWI ex USA Indexes and the MSCI Corporate and Sovereign Issuer Curves, respectively. Lower values imply equities are relatively more expensive than bonds. The dashed lines indicate the respective historical means.
Coming off the sidelines
Based on valuations, and other signals such as macroeconomic sensitivity and sentiment, our adaptive multi-factor framework favored the value factor, as of March 31, 2024, as it did at the close of last year. Investors contemplating repositioning their cash in the year ahead may wish to consider the impacts of the changing equity-credit relationship and growing regional disparities as they revise their allocations.
1 USD total returns for the MSCI ACWI Investable Market Index (IMI) and MSCI Developed Markets Government Bond Index are used for global equity and global bond returns, respectively.2 Total financial assets in U.S. money-market funds reached approximately USD 6 trillion in late 2023 according to the U.S. Federal Reserve. “Money Market Funds; Total Financial Assets, Level,” Federal Reserve Bank of St. Louis.3 The MSCI ACWI IMI captures large-, mid- and small-cap representation across 23 developed markets and 25 emerging markets.4 Premium refers to a three-month 95% put option on the U.S. equity market.
The content of this page is for informational purposes only and is intended for institutional professionals with the analytical resources and tools necessary to interpret any performance information. Nothing herein is intended to recommend any product, tool or service. For all references to laws, rules or regulations, please note that the information is provided “as is” and does not constitute legal advice or any binding interpretation. Any approach to comply with regulatory or policy initiatives should be discussed with your own legal counsel and/or the relevant competent authority, as needed.